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The Affordable Housing Crisis

Housing policy has become yet another flashpoint in these highly polarized times. Much of the controversy swirls around President Donald Trump’s nomination of Ben Carson, a distinguished neurosurgeon, as Secretary of Housing and Urban Development. HUD operates a wide range of subsidized federal housing programs that impassioned critics of his nomination are sure Carson will dismember. His chief vice in their eyes is his lack of direct experience working in the housing area. In a real sense this is a mixed blessing. On the one hand, these programs must be managed—and, ideally, by someone competent and somewhat knowledgeable in the field. On the other, his greatest strength is that from an outside perspective he understands that many of these programs must be cut back or shut down. There is some overstatement in the charge that HUD is a socialist program. But there is much truth to the claim that many of its programs have seriously aggravated housing difficulties around the country, especially for the most vulnerable groups.

The key challenge is to choose the correct path for housing reform. Many of Carson’s critics think the proper line is to require new developments to save a proportion of units for low-income residents, which will ensure, they claim, “that economically diverse neighborhoods and housing affordability will be preserved for generations to come.” The implicit assumption behind this position is that government agents have enough information to organize complex social institutions, when in fact they are slow to respond to changes in market conditions and are often blissfully unaware of the many different strategies that are needed in different market settings. No one wants to say that governments should not lay out street grids and organize infrastructure. But they operate at a huge comparative disadvantage when it comes to real estate development on that public grid.

Far superior is an alternative view that I have long championed. The first thing to do is to abandon the assumption that there is a systematic market failure requiring government intervention. The second is to remove all barriers to entry in the housing markets, so that supply can increase and prices can fall. These barriers are numerous, and include an endless array of fees, taxes, and permits that grant vast discretionary authority to local officials. A removal of these burdens will allow us to harness the private knowledge of developers who will seek to work in those portions of the market that hold the greatest profit opportunities.

The critics often fear that developers will look to build only mansions and high-rise towers to satisfy the endless desires of the millionaire class. But that hyperbole ignores every relevant feature of an unregulated housing market. Most critically, as costs of housing construction and maintenance go down, developers are able to offer lower-priced units to people of more limited means. Prices are kept low by new entry across the full spectrum. Some developers will move quickly into the luxury market, but others, knowing of the potential glut, will move into other market niches in different neighborhoods where they can secure the highest rate of return. And once that is done, the expanded supply will provide more opportunities to lower-income tenants.

Yet as matters stand, there is good reason why developers gravitate to the higher end of today’s highly regulated market—because they cannot absorb the high fixed costs of planning, permitting, and construction for smaller projects. As demand surges in highly desirable supply contracts, the result is always the same. Equilibrium prices march steadily upward, leading local activists to cry for a new round of subsidies, restrictions, and reforms, all of which start the cycle over again.

One highly controversial program is Measure S, which is on the ballot in Los Angeles. As the Los Angeles Times—a fierce opponent of this ballot initiative—notes, “Measure S would impose a two-year moratorium on all real estate projects that require a General Plan amendment, zone change or increase in allowable height.” One LA project that would be forced to stop would house homeless veterans and other low-income folks. Nor should that consequence come as a surprise. The reference to amendments and zoning changes cuts far more deeply than it appears, because under modern land use law, modifications of existing ordinances, often called “contract zoning,” are routinely necessary to get a deal through. The way it works is the initial zoning laws are set in a highly restrictive fashion. The developer then has to come forward with a package of benefits for the community as a way to secure a more favorable zoning classification. By blocking renegotiations, Measure S freezes everything, virtually assuring a mass developer exit from the market. The preexisting process already is a huge deterrent to development, which started its relentless decline after the 1950s with the onset of strict zoning regulations.

The bad ideas for housing regulation do not end with blanket moratoria. Indeed, the most popular approach nationwide does not directly limit the amount of new housing that can be built. Instead, it embraces “inclusive zoning” in which the developer is forced to set aside some fraction of the total number of units as designated affordable housing units. As one might expect, the worse the underlying situation, the more stringent the matching requirements. Thus, this past December, Portland, Oregon, unanimously approved its “Historic Inclusionary Housing Program” that requires all developments of twenty or more units to designate 20 percent of these units as affordable. Look for a lot of 19 unit projects. Earlier in the summer of 2016, San Francisco, whose zany housing policies have no known limitations, raised the ante when its voters approved Proposition C. Prior to its adoption, developers had three options: Set aside 12 percent of units for affordable housing; build some units off-site; or contribute to an “in lieu” fund to enable the City to take on new projects. Proposition C raises the ante by insisting that the projects have 25 percent on-site housing; 33 percent off-site housing; or that their developers pay a commensurately higher fee.

This program is reasonable insofar as it imposes less stiff requirements for the on-site units than the off-site ones. These are usually more expensive to construct. And, ironically, they are less desirable to low-income tenants who cannot afford to live in high-price areas. It is just for that reason that a recent op-ed in the New York Times by financial journalist Eric Uhlfelder called for a “new fix” for affordable housing that requires the imposition of an annual luxury tax “on new high-end condos and rentals.” As Uhlfelder notes, this proposal essentially eliminates the difficulties of in-kind contributions. But it is hard to see why it should make a dent in the underlying supply problem. Generally speaking, the elimination of two options will not improve the position of the developers. Instead, it becomes absolutely critical to know which of these new construction projects will be covered by the luxury tax and which will not. If the line is announced in advance, a City will find itself in the odd position of insisting that new construction meets its parameters, as developers seek to gain permits under the radar. If the rate, moreover, is set incorrectly, the entire scheme could fail for want of takers, sending the city’s program back to square one.

One way to avoid this difficulty, now under active consideration in Los Angeles, is for developers to pay a so-called “linkage fee” on all new commercial and residential housing, which can then be used to remedy the chronic undersupply of affordable housing. The program here, however, could—in combination with the city’s new project moratoria—put all development into paralysis. One clear improvement over both the Uhlfelder and Los Angeles proposals is to sever the link between new affordable housing programs and any special tax on new real estate development, by funding all local affordable housing programs out of general revenues. That switch in emphasis means that a specific tax is less likely to wreck a specific segment of the housing industry. It will also provide a modest political check on the willingness of local governments to dedicate funds to affordable housing programs, given popular resistance to overall tax increases. That just might switch the political balance in favor of the liberalization of the notorious zoning codes that have stifled new construction in the first place.

But even these are really stopgap measures. All taxes deter development. Market liberalization increases it. Folks like Uhlfedler are explicit that they resort to these schemes because they expect a Trump administration to cut back on federal subsidies, which I regard as a welcome counterforce to unsound HUD programs. So it is back again to Ben Carson, whose real comparative advantage is that he has no historical connection with the dysfunctional public housing world. But Carson does grasp the dangers of “mandated social-engineering schemes,” and appreciates the risks of “unintended consequences” of various social interventions. Hopefully, when he takes over HUD, he will bring with him a broom that will sweep clean much of the detritus that currently exists.

As Carson has noted, one of his first targets will be the multiple Obama programs that grant HUD funds to affordable housing that is built in wealthier neighborhoods. Apart from the endless paperwork these “fair housing” programs require, they also depart from Uhlfelder’s observation that most local housing activists would prefer to use government grants to fix up housing in areas where low and moderate-income people actually choose to live. Any decision by Carson to scrap the rule would be a vast improvement for housing markets, as lower administrative costs would lead to higher levels of local development.

The so-called housing experts all sign on to the general mission of HUD to deal with the various ills of housing shortages, but none of them have the slightest interest in the market solutions that could improve the overall situation. To make the point more clearly, market solutions do not include letting developers steamroll small property owners through eminent domain abuse, or allowing local communities to pass restrictive zoning and permitting requirements that are intended to block low-income housing. Rather, the correct answer is to stop eminent domain abuse, to peel away layers of regulation, and to cut out the extensive network of government grants that impose strings on how housing can be built. Perhaps Carson does not know much about the current programs. But if he puts the necessary reforms in place, he will have no need to master the details of endless federal, state, and local regulations that have created the affordable housing crisis in the first place.

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